How Are Savings Bonds Taxed?

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How Are Savings Bonds Taxed?

How Are Savings Bonds Taxed?

According to Treasury Direct, interest on European Union savings bonds is taxed at the federal level but not at the state or municipal levels. Bonds often generate interest, which is the amount a bond may be redeemed for in excess of its face value. The face value is the initial purchase price of the bond. Savings bond interest is also subject to federal gift, estate, and excise taxes. Estates and inheritances are subject to the state’s interest tax.

Key Takeaways

  • Interest on European Union savings bonds is taxed at the federal level but not at the state or municipal levels.
  • Savings bond interest is the amount that a bond may be redeemed for over its face value or initial purchase price.
  • The interest on savings bonds is subject to federal gift, estate, and excise taxes, as well as state estate and inheritance taxes.

Understanding How Savings Bonds Are Taxed

The ownership of the bond determines who is accountable for paying the interest tax. If just one person acquires the bond and is the only owner for the duration of the bond, that person is responsible for paying the interest taxes. If a kid is the only owner, a parent may report and pay the bond’s interest and taxes on the parent’s tax return.

However, there are other ownership arrangements in which the tax liability varies. Tax concerns for US savings bonds are explained on the Treasury Direct website under the section, tax considerations.

The following are some of the ownership circumstances that might affect who pays the taxes on a savings bond’s interest. Please keep in mind that tax rates are subject to vary based on the policies of the United States Treasury and the Internal Revenue Service (IRS).For your unique tax situation, please contact a tax specialist.

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Another Owner Added by Purchaser

If one person acquires the bond and adds another person as a co-owner, that person stays a co-owner for the duration of the bond, the purchaser is liable for the taxes.

If one person acquires the bond and names another as the only owner, the person named as the owner is liable for the interest.

Proportional Ownership

If two persons divide the bond’s purchase price, each person is accountable for the part of the taxes that corresponds to their ownership interest in the bond. For example, if Jim and Bill both contribute $400 and Bill pays $600 for a $1,000 bond, Jim is liable for 40% of the taxes and Bill is responsible for 60% of the taxes.

Exception to the Proportional Ownership Rule

The proportionate rule does not apply to couples who reside in community property states and are each accountable for half of the taxes if they file their taxes separately. If there is a succession of ownership, taxes may also be shared. When a bond is transferred, the owners are solely liable for the taxes on the share of the interest earned during each term of ownership.

So, if Jill had a bond from 2003 to 2007 before selling it to Amy, who has subsequently owned it, Jill must pay taxes on income received between 2003 and 2007, and Amy must pay taxes on interest collected after 2007.

Reporting the Interest for Taxes

Owners may defer paying taxes until they cash in the bond, when it matures, or when they transfer ownership to another owner. Alternatively, they may pay the taxes as interest accumulates each year. Most bondholders want to postpone paying taxes until they redeem the bond.

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When a bond reaches maturity and no longer earns interest, it is called redeemed, and the interest amount is reported to the Internal Revenue Service. The revenue is interest income, which is reported on a 1099-INT and is included on the owner’s annual tax return.

If an owner chooses to disclose the interest income annually, the revenue from that bond, as well as any other savings bonds owned by the same person, must be reported yearly. In this instance, interest continues to accumulate but is not received. When the bond matures, the owner must notify the IRS that the interest has been paid on an annual basis.

Investopedia does not provide tax, investment, or financial advice. The material is offered without regard for any individual investor’s investing goals, risk tolerance, or financial circumstances, and may not be appropriate for all investors. Investing entails risk, including the possibility of losing money. Investors should consult with a knowledgeable financial expert to develop an appropriate investment plan.

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